Winding Up Bear: Paulson's Gift to His Bankster Buddies

Winding Up Bear: Paulson's Gift to His Bankster Buddies

By Mike Whitney

Created Mar 21 2008 - 11:15am

One picture tells the whole story. It's a photo of five grim looking men in

gray suits staring ahead blankly like they were in the dock with Saddam

awaiting sentencing. Every one of them looks downcast and dejected;

shoulders rounded and jaws set. This is what desperation looks like, which

is why the photo was kept off the front pages of the leading newspapers.

The group took no questions and, as far as the media was concerned, the

meeting never happened. But it did happen; and it happened on Monday at the

White House at 2PM. That's when President Bush convened the Working Group on

Financial Markets, also known as the Plunge Protection Team, to explain

their strategy for dealing with deteriorating conditions in the financial

markets. The details of the meeting remain unknown, but judging by the

sudden (and irrational) recovery in the stock market on Tuesday; their plan

must have succeeded.

The Plunge Protection Team is a panel that includes Fed Chairman Ben

Bernankee, Treasury Secretary Henry Paulson, Securities and Exchange

Commission Chairman Christopher Cox, and acting Commodity Futures Trading

Commission head Walter Lukken. According to John Crudele of the New York

Post, the Plunge Protection Team's (PPT) objective is to redirect the stock

market by ""buying market averages in the futures market, thus stabilizing

the market as a whole."" In the event of a terrorist attack or a natural

disaster, the group's activities could play an extremely positive role in

saving the market from an unnecessary meltdown. However, direct intervention

into supposedly "free markets" is less defensible when it is merely a matter

of saving an over-leveraged banking system from its inevitable Day of

Reckoning. And, yet, that appears to be the reason for the White House

confab; to buy a little more time before the final explosion.

The psychology behind the PPT's activities is explained in greater detail by

Robert McHugh Ph.D. who provides a description of how it works in his essay

""The Plunge Protection Team Indicator"":

The PPT decides markets need intervention, a decline needs to be stopped, or

the risks associated with political events that could be perceived by

markets as highly negative and cause a decline, need to be prevented by a

rally already in flight. To get that rally, the PPT's key component -- the

Fed -- lends money to surrogates who will take that fresh electronically

printed cash and buy markets through some large unknown buyer's account.

That buying comes out of the blue at a time when short interest is high. The

unexpected rally strikes blood, and fear overcomes those who were betting

the market would drop. These shorts need to cover, need to buy the very

stocks they had agreed to sell (without owning them) at today's prices in

anticipation they could buy them in the future at much lower prices and

pocket the difference. Seeing those stocks rally above their committed

selling price, the shorts are forced to buy -- and buy they do. Thus, those

most pessimistic about the equity market end up buying equities like mad,

fueling the rally that the PPT started. Bingo, a huge turnaround rally is

well underway, and sidelines money from Hedge Funds, Mutual funds and

individuals' rushes in to join in the buying madness for several days and

weeks as the rally gathers a life of its own. (Robert McHugh Ph.D., "The

Plunge Protection Team Indicator")

The powers of the PPT are greatly exaggerated; eventually the liquidity they

provide has to be drained from the system. The popular myth that the Fed

simply creates as much money as it chooses and spreads it around like

confetti; is pure rubbish. The Fed has very definite balance constraints.

The system is not quite as rigged as many people imagine. According to

Bloomberg News, the Fed has already depleted most of its resources:

The Fed has committed as much as 60 percent of the $709 billion in Treasury

securities on its balance sheet to providing liquidity and opened the door

to more with yesterday's decision to become a lender of last resort for the

biggest Wall Street dealers." ("Bernanke May Run Low on Ammunition for

Loans, Rates", Bloomberg)

The troubles in the credit markets and real estate are bigger than the Fed

or the PPT; and they know it. The next step is massive government

intervention; mortgage-rate freezes, bailouts and fiscal stimulus. Big

government is back; Reaganism has gone full-circle. That doesn't mean that

the PPT cannot have an important psychological affect in soothing jittery

markets or stalling a system-wide collapse. It just means, that markets will

eventually correct regardless of what anyone does to stop them. The sharp

downturn in the financial markets is the result of unsustainable credit

expansion that can't be fixed by the parlor tricks of the PPT. The rate at

which financial institutions are deleveraging and destroying capital will

inevitably trigger an economic crisis equal to the Great Depression. What is

needed is strong leadership and a re-commitment to transparency, not "more

of the same" low interest crack and financial hanky-panky. It's time to come

clean with the public and admit we have a problem.

"Sucker rallies", like Tuesday's 400 point surge on Wall Street just helps

to conceal the deeply rooted problems that need to be addressed before

investor confidence can be restored. Blogger Rick Ackerman summed it up

succinctly in last night's entry:

These psychotic, 400-point rallies in the Dow do not augur renewed

confidence. They are being driven almost entirely by short-covering, and

even the otherwise clueless news anchors are starting to dismiss them as

meaningless. One of these days, moments after the last surviving bear's

short position has been liquidated, stocks are going to fall so steeply that

even the Plunge Protection Team will call for back-up. Then, the financial

collapse that so many have been expecting will unfold in just a few days,

with enough power to leave the global economy in ruins for a generation."

(Rik's Piks Rick Ackerman)

Whether Ackerman's dire predictions materialize or not, there's no denying

that the situation is getting worse by the day. In the last week alone, two

major financial institutions, Carlyle Capital and Bear Stearns have either

gone under or been bailed out wiping out tens of billions in market

capitalization. These flameouts have increased the rate of the deflation

adding to the already-prodigious losses from housing foreclosures,

delinquent credit card debt, defaulting car loans, and the deleveraging in

the hedge fund industry. Fortress America has sprung a leak, and capital is

escaping in a torrent.

"One thing is for certain, we're in challenging times," Bush opined on

Monday after meeting with his top economic aides. ""But we are on top of the

situation."

That's comforting. Bush is all over it.

Tuesday's 75 basis point rate cut by the Fed is another sign of desperation.

The Fed Funds rate is now 2 percentage points below the rate of inflation; a

obvious attempt on Bernanke to reflate the equity bubble at the expense of

the dollar. Is that why Wall Street was so jubilant; another savage blow to

the currency?

The Fed's statement was as bleak as any they have ever released sounding

more like passages from the Book of the Dead than minutes of the Federal

Open Market Committee:

Recent information indicates that the outlook for economic activity has

weakened further. Growth in consumer spending has slowed and labor markets

have softened. Financial markets remain under considerable stress, and the

tightening of credit conditions and the deepening of the housing contraction

are likely to weigh on economic growth over the next few quarters.

Inflation has been elevated, and some indicators of inflation expectations

have risen .... uncertainty about the inflation outlook has increased. It

will be necessary to continue to monitor inflation developments carefully.

Today's policy action..should help to promote moderate growth over time and

to mitigate the risks to economic activity. However, downside risks to

growth remain.

Wall Street rallied on the cheery news.

Also, on Tuesday, the battered investment banks began posting first quarter

earnings which turned out to be better than expected. Goldman Sachs Group

Inc. and Lehman Brothers Holdings Inc. beat estimates which added to the

stock market giddiness. Unfortunately, a careful reading of the reports,

shows that things are not quite as they seem. The jubilation is unwarranted;

it's just more smoke and mirrors.

"Lehman Brothers Holdings Inc. reported a 57% drop in fiscal first-quarter

net income amid weakness in its fixed-income business, though results topped

analysts' expectations." (Wall Street Journal)

The same was true of financial giant Goldman Sachs:

"Goldman Sachs Group Inc.'s fiscal first-quarter net income dropped 53% on

$2 billion in losses on residential mortgages, credit products and

investments ...The biggest Wall Street investment bank by market value

reported net income of $1.51 billion, or $3.23 a share, for the quarter

ended Feb. 29, compared to $3.2 billion, or $6.67 a share, a year

earlier....Results included $1 billion in losses on residential mortgage

loans and securities, and nearly $1 billion in losses on credit products and

investment losses ..." (Wall Street Journal)

The bottom line is that both companies first quarter earnings dropped by

more than a half in just one year alone while, at the same time, they booked

heavy losses. That's hardly a reason for celebration. The major investment

banks remain on the critical list because of the billions of dollars of

toxic debt they still carry on their balance sheets. Consider industry

leader Goldman Sachs, for example, which is sitting on a backlog of bad

paper from the subprime/securitization debacle as well as an unknown amount

of LBOs (Leveraged buyouts) and commercial real estate deals (CREs) that are

heading south fast. Market analyst, Mark Gongloff, sheds a bit of light on

the real condition of the big financials in his article ""Crunch Proves A

Test of Faith For Street Strong"":

"All of the brokerage houses are highly leveraged, with a high ratio of

assets to shareholders' equity, a sign they have used debt heavily to build

up positions in hope of greater returns. Morgan Stanley, which will report

Wednesday, had a leverage ratio of 32.6-to-1 at the end of last year, nearly

as high as Bear's 32.8-to-1. Lehman was leveraged 30.7-to-1, and Merrill

Lynch 27.8-to-1. And the would-be rock, Goldman? It was leveraged

26.2-to-1.""(""Crunch Proves A Test of Faith For Street Strong", WSJ)

Remember, Carlyle Capital was leveraged 32 to 1 ($22 billion equity) and

went ""poof"" in a matter of days when it couldn't scrape together a measly

$400 million for a margin call. How vulnerable are these other maxed-out

players now that the credit bubble has popped and the whole system is

quickly unwinding?

Not very safe, at all. As Gongloff points out:

"Based in part on numbers reported at the end of Bear's fourth quarter,

estimated that Bear Stearns had $35 billion in liquid assets and borrowing

capacity, enough to operate for 20 months. Turns out it had enough for three

days.""

That's right; three days and it was over. Why would anyone think it will be

different with these other equally-exposed banks? These institutions are

basically insolvent now. The Federal Reserve is just trying to prop them up

to maintain appearences. But it's a hopeless cause. As hyper-inflated assets

are downgraded; structured investments and arcane hedges against default

will continue to disintegrate and these profligate institutions will be

crushed by a stampede of panicking investors. The flight to safety has

already begun. Cash is king.

Look what has transpired just since Monday.

"Crude oil, copper and coffee led the biggest decline ever in commodities on

speculation that a U.S. recession will stall demand for raw materials."

(Bloomberg) All asset classes fall in a deflationary spiral, even

commodities which many people thought would be spared. Not so. In fact, even

gold has begun to retreat as hedge funds and other market participants are

forced to relinquish their positions.

In other news, Reuters reports:

"The yield on U.S. 3-month Treasury bills fell below 1 percent on Monday to

levels not seen in 50 years prompted by intense safety bids for cash spurred

by the ongoing global credit crunch...Investors were pulling money out of

stocks and even the booming commodity market even after the Federal Reserve

conducted a fresh round of measures over the weekend to alleviate the credit

crisis."

Here's another example of the "flight to safety" as investors recognize the

warning signs of deflation. This trend is likely to intensify even though

the Fed will continue to cut rates and real earnings on Treasuries will go

negative. In another report from Reuters:

""The Chicago Board Options Exchange Volatility Index or VIX on Monday

surged to its highest level in nearly two months as a fire sale of Bear

Stearns and an emergency Federal Reserve cut in the discount rate reignited

credit fears."

Fear is higher now than it has been in a long time. Option traders are

loading up on index puts in the Standard & Poor's 500 index. The "Fear Gage,

as it is called, is soaring to new heights as credit problems continue to

mount and business begins to slow to a crawl.

And, perhaps most important of all:

"The cost of borrowing in dollars overnight rose by the most in at least

seven years after the Federal Reserve's emergency cut in the discount

interest rate stoked concern that credit losses are deepening....The London

interbank offered rate, or Libor climbed 81 basis points to 3.86 percent,

the British Bankers' Association said today. It was the biggest increase

since at least January 2001. The comparable pound rate rose 28 basis points

to 5.59 percent, the largest gain since Dec. 31, 2007." (Bloomberg)

This may sound like technical gibberish geared for market junkies, but it is

critical for understanding the gravity of what is really going on. The Fed's

rate cuts are not normalizing the lending between banks. In fact, the

situation is actually deteriorating quite quickly. When banks don't lend to

each other (because they are worried about getting their money back) the

wheels of capitalism grind to a halt. The banks are the essential conduit

for providing credit to the broader economy. If there's a slowdown in

traffic, economic growth begins to slow immediatly. Presently, the banks are

hoarding cash to cover the losses on their mortgage-backed investments and

to shore up their skimpy capital reserves. As a result, consumer spending is

sluggish and GDP is beginning to shrink.

"We know we're in a sharp (decline), and there's no doubt that the American

people know that the economy has turned down sharply"," said Henry Paulson

on NBC television on Sunday. "There's turbulence in our capital markets and

it's been going on since August. We're looking for ways to work our way

through it."

No kidding. But Paulson is clearly out of his depth. He's simply not the man

to deal with a crisis of this magnitude. His only concern is bailing out his

rich friends in the banking industry. The interests of workers and consumers

are just brushed aside. Has anyone from the Dept of the Treasury (or the

Fed) suggested a bailout for the 14,000 Bear Stearns employees who just lost

not only their jobs but the entire retirement when the company was purchased

by JP Morgan?

Of course, not. Because both Paulson and Bernanke take a class oriented

approach to the problem that narrows their range of vision and limits their

ability to pose viable remedies. They are unable to see the whole playing

field. For example, Bernanke assumes that if he keeps cutting rates, he can

reflate the equity bubble by stimulating consumer spending. But that is not

going happen. First of all, the banks are not passing on the savings to

customers. And, second, the banks are only lending to applicants with a

flawless credit history. In other words, the Fed's cuts may be good for

Bernanke and Paulson's buddies, but they do nothing for either the consumer

or the broader economy. Also, as Michael Hudson notes in his latest article

"Save the Economy, Dismantle the Empire" (counterpunch.org) the banks are

taking the money they borrow from the Fed and investing it elsewhere:

"This week the Fed tried to reverse the plunge in asset prices by flooding

the banking system with $200 billion of credit. Banks were allowed to turn

their bad mortgage loans and other loans over to the Federal Reserve at par

value (rather at just 20% "mark to market" prices). The Fed's cover story is

that this infusion will enable the banks to resume lending to "get the

economy moving again." But the banks are using the money to bet against the

dollar. They are borrowing from the Fed at a low interest rate, and buying

foreign euro-denominated bonds yielding a higher interest rate--and in the

process, making a currency gain as the euro rises against dollar-denominated

assets. The Fed thus is subsidizing capital flight, exacerbating inflation

by making the price of imports (headed by oil and other raw materials) more

expensive. These commodities are not more expensive to European buyers, but

only to buyers paying in depreciated dollars.""

The banksters are "buying foreign euro-denominated bonds" during an economic

crisis in America? Whoa. Now there's an interesting take on patriotism.

The Fed's strategy has even failed to lower mortgage rates which are pinned

to the 30-year Treasury and which has actually gone up since Bernanke began

slashing rates. This inability to pass on the Fed's rate cuts to potential

mortgage applicants ensures that the housing meltdown will continue unabated

well into 2009 and, perhaps, 2010.

In the last few days, the Fed has provided $30 billion to buy up the

least-liquid speculative debts of a privately-owned investment bank, Bear

Stearns, which was leveraged at 32 to 1 and which will remain unsupervised

by federal regulators. How does that address the underlying issues of the

credit crunch? Are Bernanke and Paulson really trying to put the financial

markets back on solid footing again or are they merely expressing their

bank-centered bias?

That question was answered in an article on Tuesday in the Wall Street

Journal which explained the real reasons behind the Bear bailout:

"The illusion was shattered Saturday morning, when Mr. Paulson was deluged

by calls to his home from bank chief executives. They told him they worried

the run on Bear would spread to other financial institutions. After several

such calls, Mr. Paulson realized the Fed and Treasury had to get the J.P.

Morgan deal done before the markets in Asia opened on late Sunday, New York

time.

"It was just clear that this franchise was going to unravel if the deal

wasn't done by the end of the weekend," Mr. Paulson said in an interview

yesterday.'" ("The Week that Shook Wall Street", Wall Street Journal)

So all it took was a little nudge from his banking cohorts for Paulson to

swing into action and firm up the deal. That says it all. The interests of

the American people were never even considered. It was all choreographed to

bail out the financial industry. No wonder so many people believe that the

Federal Reserve and the US Treasury are merely an extension of the banking

establishment. The Bear bailout proves it.

--

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"A little patience and we shall see the reign of witches pass over, their

spells dissolve, and the people recovering their true sight, restore their

government to its true principles. It is true that in the meantime we are

suffering deeply in spirit,

and incurring the horrors of a war and long oppressions of enormous public

debt. But if the game runs sometimes against us at home we must have

patience till luck turns, and then we shall have an opportunity of winning

back the principles we have lost, for this is a game where principles are at

stake."

-Thomas Jefferson